Japan's America Problem

Is there anything Tokyo can do to jump-start its economy? Actually there is, and it's simple and effective: bring on a little inflation. The noted economist Paul Krugman has pointed out that the only way to get Japanese companies and consumers to stop saving and start spending is to convince them that things will be cheaper today than tomorrow. The Bank of Japan could simply announce that it is targeting a 2 percent rate of inflation (rather than the current one, which is below zero), creating a rush of spending. Such a move would also ease the financial crisis, since asset prices would rise and debts would be easier to pay off, making the inevitable bank bailout cheaper.

There's one small problem with this solution--it means that the yen will fall further in value. This would actually help speed up Japan's recovery since its exports will become cheaper on world markets. But politically it's a problem. A falling yen could well lead to another round of currency devaluations in Southeast Asia and beyond. Most important, China, which may soon have to devalue its currency anyway, could take this as an opportunity to do so and blame the Japanese for having created instability and panic around the world. Tokyo is petrified of being considered irresponsible by its neighbors and by the United States. And Washington, fearing further instability in Asia, and particularly in China, has consistently suggested that Japan take every measure it can to boost its economy--other than spurring inflation.

Thus a sensible Japanese economic policy appears to be pitted against a sensible foreign policy. But Washington should recognize that Japan is 75 percent of Asia's economy. If it doesn't grow, none of Asia will. A policy of inflation in Japan has its costs. Were Japan to inflate, while there might be a short panic after the yen drops, Japan and the United States could shore up other regional currencies--thus demonstrating its good intentions to the world in general and China (and the United States) in particular. Sometimes tough economic policy can also be the right foreign policy.

© 1998